Regulation 6801

Under a sabbatical leave plan (the Plan):

• Participating employees elected to purchase credits towards a future sabbatical leave by deferring receipt of their salary for a specified number of days each year, with the employer matching this purchase by making a “notional contribution” towards the cost of the future sabbatical leave using a predetermined formula.
• The accrual period during which employees could elect to purchase such credits was between three and seven years, with the sabbatical leave to be taken no later than the seventh calendar year after the first year in which accruals commenced.
• Employee generally could elect to take a sabbatical leave corresponding to the number of weeks so purchased, together with the employer notional contributions, with their current salary being received for the duration of the leave, but with receipt of a top-up amount from the employer if their salary increased over the accrual period.
• If an employee’s employment terminates before taking the accrued sabbatical, the employer’s notional contributions would be forfeited and the employee would receive a lump-sum payment equaling the unrealized deferred salary.

CRA stated:

The Plan as described above will not meet the requirements of paragraph 6801(a) of the Regulations as a DSLP (for multiple reasons including the length and timing of the sabbatical leave and the notional employer contributions).

In addition to providing a comprehensive discussion of the deferred salary leave plan (“DSLP”) rules, CRA addressed the question whether employees working 10 months a year who are temporarily laid off during the summer without being on the recall list but having already been granted an assignment for the next school year, can participate in the plan, as follows:

If, at the time the agreement is made with an employee, the parties expect the employee to lose his or her employment during the plan, the plan would not qualify as a DSLP in respect of the employee and paragraph 6801(a) would not apply. In this case, deferred amounts should be included in the employee's income in the taxation year in which they are earned and deferred rather than in the year in which they are paid to the employee.

However if, at the time the agreement is made with an employee, it is clear from all the facts of the situation that the employee will meet all the requirements of paragraph 6801(a), being temporarily out of work during the summer period should not, in and of itself, prevent the employee from participating in a DSLP.

Other points made included:

• Although Reg. 6801(a) refers to an “arrangement,” CRA expects to see an agreement describing the terms and how the deferred amounts will be held.
• If there is a trust arrangement, this will be an EBP, with the interest income therefrom being taxed currently in the employees’ hands net of plan expenses.
• A hybrid arrangement is permitted in which, during the employee’s leave, the employee first receives amounts whose recognition was deferred under the DSLP rules, and then receives advances of salary or wages which are to be earned after returning, with such amounts in both cases being included in the employee’s income under ss. 6(3) and 5(1).
• In this type of arrangement (or one where the employee only receives advances during the leave – in which case, it is not within the DSLP rules), the employee is entitled to a s. 8(1)(n) deduction as the advances are “repaid” (i.e., out of reduced pay cheques following the return to work).
• Although under the DSLP rules the employee cannot receive salary or wages during the leave, reasonable fringe benefits are permitted.
• The employee is required to return to work for at least the period of the leave - so that, for example, an employee who worked 20 hours per week before a six month leave, could not return to work for only three months at 40 hours per week.
• Upon death or retirement of the employee, the deferred amounts are immediately recognized.

underline;">: Sabbatical Fund. A self-funded sabbatical program is to be implemented as agreed under a Collective Agreement. During XX consecutive years, the "Employer" will withhold XX% of a regular employee's (a "Participant's") "Base Salary" (e.g., excluding overtime) and will maintain this amount in a "Sabbatical Fund" for the Participant's benefit. The Sabbatical Fund will bear interest, and such interest will be reported annually as employment income.

Sabbatical Year

During the Sabbatical Year: the Participant will be on a leave of absence from the Employer and shall receive as compensation the monies accumulated in the Sabbatical Fund, plus interest not yet paid to the Participant and shall be subject to all deductions required by law; and other than such amounts paid to the Participant, he or she will not receive any salary or wages, except for reasonable fringe benefits (including insurance coverage) that the Employer usually pays to or on behalf of its employees. The Participant may make a one-time election for payment, less applicable withholdings required by law or otherwise, in one lump sum payment at the beginning of the Sabbatical Year, or payment on a weekly basis. The Participant has the option of maintaining, through the Employer, extended health benefits, dental plan and supplemental term life insurance and spousal child/life coverage by the Participant's pre-payment, to the Employer prior to commencement of the Sabbatical Year, of XX% of the applicable premiums in one lump sum.

Cash-outs

On completion of the Sabbatical Year, the Participant must return to work subject to limited exceptions, and a Participant may not withdraw from the Plan except in limited extenuating circumstances such as financial hardship. A Participant who ceases to be employed by the Employer is deemed to have withdrawn from the Plan and will be paid the Sabbatical Fund plus interest. On death, such payment is made to the estate.

Ruling

The Plan will not constitute a salary deferral arrangement…by virtue of the Plan qualifying…as a prescribed plan or arrangement pursuant to paragraph 6801(a)… ." of the Regulations.

In the course of providing a detailed discussion (similar to that in 2016-0643191E5 F) of the DSLP rules in relation to a copy of a plan that had been submitted to it, the Directorate made various comments on perceived deficiencies in the terms, including that:

• the “plan should … be amended to provide that early withdrawal from the plan may only take place in specific circumstances set out in the plan and subject to the employer's discretion”
• the plan should be amended to clarity that the “deferral period does not exceed six years and all amounts held under the DSLP are paid to the employee by the end of the first taxation year commencing after the deferral period”
• the “plan provides that an executive on leave without pay, disability or parental leave may participate in the plan, but the leave cannot begin until the date of return to work. It appears to us that an executive who participates in the plan in such circumstances would take the leave without first having had a deferral period. In such a case, the leave would be funded solely from salary advances and would not constitute a DSLP.”
• “your plan specifies that an executive who avails himself or herself of the plan must return to "XXXXXXXXXXXX" employment. In this sense, your plan does not appear to us to require the executive to return to employment if he or she takes the leave in the last year of the Master Agreement. This is contrary to the Regulations [subparagraph 6801(a)(v)], which requires the employee to return to his or her regular duties for a period at least equal to the duration of the leave, regardless of whether the leave is taken during the Master Agreement or at the end of the Master Agreement.”

Discussion of deficiencies in draft DSLP to be included in a school board's collective agreement.

Comments on various deficiencies in proposed draft DSLP.

A deferred salary leave plan will cease to be a prescribed plan at the time that it is reasonable to assume that the conditions of the plan will not be fulfilled and could be subject to the salary deferral rules from its inception. Where, due to a change in circumstance, the employee decides to leave his employment, a penalty will be imposed.

If a teacher is employed but is not required to report to work between semesters, the time between semesters may be included in the calculation of the minimum six-month period for purposes of Regulation 6801(a).

A Canadian public company (Employerco) proposed that the share appreciation right (SAR) units of its employees be converted into an equivalent value of deferred share units (DSUs), with the payout of the referenced number of shares on the retirement etc. of each employee participant to be taken care of by a an employee’s profit sharing plan (EPSP) trust (settled by Employerco at the time of the conversion into DSUs). The EPSP trust would use an interest-bearing loan from Employerco to fund its purchase of the matching number of Employerco shares and fund the loan interest with dividends on the shares and annual contributions from Employerco – both of which were taxable income to it but with an offsetting interest deduction, so that there would be no annual income inclusion to the participant under s. 144(3). On retirement, Employerco would make a further contribution (deducted by it under s. 144(5)) to enable the EPSP Trustee to repay the applicable portion of the loan, with that amount being included in the participant’s income under s. 144(3), and the EPSP trust would distribute the shares to the participant. Further similar features provided participants with dividend-equivalent DSUs and subsequent pay-out.

CRA found that this plan “failed on technical grounds,” i.e.:

The Proposed Transactions would result in immediate income tax consequences to the Participants on either one of the following bases:

• The conversion of the units from SARs to DSUs and adding dividend equivalents would represent a fundamental change to the Participant’s rights under the Plan, and therefore there would be an immediate disposition of the units. As a result, the Participant would be considered to have received an amount equal to the fair market value (FMV) of the Participant’s units and be required to include that amount in income from employment in the year in which the disposition occurs.
• The conversion of the units from SARs to DSUs would breach the post-amble of paragraph 6801(d) of the Income Tax Regulations, resulting in the Plan becoming a salary deferral arrangement (as defined in subsection 248(1) of the Act). In the circumstances, there would be an immediate income inclusion by virtue of subsection 6(11) and paragraph 6(1)(i) of the Act to the Participant for the FMV of the Participant’s units.

CRA went on to indicate that even if this structure were instead implemented on a prospective basis, it would refer it to the GAAR Committee as being abusive.

(a) CRA has ruled ((e.g. 2005-0144541R3) that units of a 3-year bonus plan that satisfied the conditions of para. (k) in the definition of SDA could be converted, without realizing tax, to units of a DSU plan that satisfied the conditions of Reg. 6801(d). Why has CRA discontinued providing such rulings? CRA responded:

When considering the conditions that must be satisfied under paragraph (k) of the definition of SDA and paragraph 6801(d), a conversion of rights under a 3-year bonus plan to rights under a DSU plan, or vice versa, will not satisfy the conditions under either paragraph (k) or 6801(d). In such circumstances, the conversion of rights under what was a 3-year bonus plan could effectively permit the payment of an amount after the third calendar year, and the conversion of rights under what was a DSU plan could result in the payment of an amount prior to death, retirement or termination of employment. Accordingly…the terms of a plan cannot under any circumstance provide a taxpayer with conversion rights.

(b) Can a DSU plan provide for payments to be made in accordance with the permissible distributions events in section 409A of the Code and still comply with the requirements of Reg. 6801(d)? CRA responded:

The timing of payments under section 409A can be earlier than the timing of a factual loss of office or employment required under paragraph 6801(d). … For example, section 409A permits payments to be made as a result of a reduction in service to less than 20% of the previous level, a change in control of the employer or an unforeseeable emergency.

Consequently, it is our view that a DSU plan could not provide for the full range of distribution events permitted by section 409A… and still comply with paragraph 6801(d).

(c) When do these revised positions become effective? CRA stated, respecting “3-year bonus plans and DSU plans that relied on the positions reflected in these published rulings” but for which no ruling was sought, that:

The CRA will continue to apply the positions in [the] published rulings to any units credited on or before November 24, 2015 (including units with unexercised conversion rights on that date), as well as to additional units credited at any time in respect of those units, for example, dividend equivalents and proportional adjustments due to stock splits or corporate reorganizations.

(See also CRA’s previous oral announcement.)

Would an amendment to a deferred share unit plan, giving participants the option to be paid the value of their awards in instalments over a maximum of six years after retirement or termination of employment, cause the plan to cease to qualify under Reg. 6801(d)? CRA responded:

[T]he plan must provide for payments to be made no earlier than the employee's retirement, termination of employment or death and no later than the end of the first calendar year commencing after that time. …[Here] the plan would cease to be excluded from the SDA rules thereby resulting in the value of any outstanding awards being included in the respective employee's income. …

If it is determined based on the facts that a DSU plan was never intended to provide for payments within the time parameters of paragraph 6801(d)… the SDA rules would apply retroactively. For example, … where a DSU plan was terminated and all outstanding awards were redeemed in cash…[a]s the early redemption did not involve extraordinary circumstances…we took the position that the SDA rules applied retroactively with respect to any outstanding awards.

See also summary under s. 6(11).

When must an employee make an election to defer salary or wages by receiving DSUs instead? CRA responded:

In general, a DSU plan must require that an employee's election be made prior to the earlier time when either: (i) the employee has a right to receive the compensation and can legally enforce payment of the compensation, or (ii) the employee has unfettered control over, access to, or use of, the compensation, i.e., the employee has constructive receipt of the compensation.

underline;">: Current Plan. Under a deferred unit plan administered by the "Committee" of the Board of Directors of Aco (a listed Canadian company), three classes of deferred share units ("DSUs") may be awarded to Participants: Aco DSUs respecting the shares of Aco ("Aco Shares"); Bco DSUs respecting the listed shares of Bco ("Bco Shares"), a subsidiary of Aco; and Cco DSUs respecting shares of one of the two classes of shares of Cco, a wholly-owned subsidiary of Aco ("Cco XX Shares"). The number of DSUs allocated to a Participant and the value of those units is recorded in a notional "Account" for the Participant. The number of DSUs allocated to a Participant is calculated based on the dollar value of the Participant's deferred compensation allocated to the applicable DSU divided by the applicable share price in respect of Aco DSUs or Bco DSUs and the fair market value of a Cco XX Share in respect of a Cco DSU. Conversions between Aco DSUs, Bco DSUs and Cco DSUs are permissible in conjunction with a change of the Participants' responsibilities or subject to the approval of the Committee. Additional Aco DSUs, Bco DSUs or Cco DSUs are awarded based on dividends attributable to the underlying notional shares.

Creation of DSUs on tracking shares

Aco wishes to create "Dco DSUs" to assist in further aligning employees' interests with those investors who hold LP units of Subject LP, which indirectly owns and operate businesses throughout the world, whose units are listed, whose general partner is a wholly-owned subsidiary of Aco and which is managed by Aco and affiliates of Aco. Accordingly, the Plan will be amended to create the Dco DSUs, whose value will depend on the value of one of the two classes of shares (the "Dco XX shares") of DCo, a newly-incorporated wholly-owned subsidiary of Aco. The value of the XX shares of Dco will depend, in turn, on the value of the limited partnership units of Subject LP. The Dco XX shares are non-voting, participating with the voting Dco shares and redeemable and retractable for an amount equal to the fair market value of a Subject LP unit. Aco will subscribe for Dco XX shares, and Dco will use the subscription proceeds to purchase, on the open market, one Subject LP unit for each Dco XX share that Dco so issues.

Conversions

Subject to the prior approval of the Committee, current DSU holders may convert their existing DSUs to Dco DSUs, and Dco DSUs may be awarded from time to time to group employees. Periodically (e.g., once a year), Dco DSUs may be converted into Aco DSUs, Bco DSUs or Cco DSUs.

Rulings

The proposed amendments will not, in and of themselves, result in the Plan ceasing to satisfy Reg. 6801(d); and no amount will be included in a Participant's income under s. 5(1) or 6(1)(a) solely as a consequence of the grant of Dco DSUs or the conversion of Aco DSUs, Bco DSUs or Cco DSUs into Dco DSUs.

In order that the Corporation's liabilities will not fluctuate with the value of the "Deferred Payment Units" ("DPUs") held by participants, the Plan will be amended to provide that a DPU payment may be made to a participant by the issuance of one common share of the corporation for each whole DPU in the alternative to cash settlement, in the discretion of the Board.

Ruling that such amendment will not result in a disposition by participants or income inclusions under s. 5 or 6.

Plan with deferred stock units and 3-year bonus deferral profit sharing units "Beneficiary" means a dependant or relation of a Participant who, on the date of the Participant's death, is the individual who has been designated as the Participant's beneficiary under the Plan in accordance with applicable law, or where no such individual has been validly designated by the Participant, or where the individual does not survive the Participant, the Participant's legal representative.

underline;">: Election. Executives, who otherwise would be entitled to receive annual cash award under the short-term incentive plan (STIP) of the Corporation, which is a listed public corporation, may elect to participate in the Corporation's deferred share unit plan (the Plan) by giving a written notice by the last day of the fiscal year preceding the fiscal year to which the election is applicable. The election specifies the fixed dollar amount, or fixed percentage of the STIP cash awards otherwise receivable by the Executive for the applicable fiscal year which (subject to the discretion of the Compensation Committee not to award DSUs) will be applied to credit DSUs to the Executive's DSU account, based on the "Market Value" (5-day trailing VWAP) of the Corporation's shares on the 10^th business day following the release of the Corporation's financial statements for the particular fiscal year. The election may be changed or revoked on the same prospective basis.

Dividends

The DSU account will be credited with additional DSUs for cash distributions that would have been received if the DSUs were shares, based on the Market Value on the payment date.

Settlement

No amount is payable to an Executive prior to his or her "Termination Date" (ceasing with the Corporation or any affiliate). Settlement (by the Executive or a Beneficiary) is permitted within the following year. "The Market Value of the DSUs credited to the Executive's DSU Account as at the Settlement Date will be paid to the Executive as a lump sum in cash, after deduction of any applicable… source deductions… ." Beneficiary" is defined as "a dependant or relation of an Executive who, on… the Executive's death, is the individual who has been designated as the Executive's beneficiary under the Plan in accordance with applicable law, or [otherwise]… the Executive's legal representative."

Rulings

• The Plan will not constitute a salary deferral arrangement… pursuant to paragraph 6801(d)… .
• Provided that the Plan remains unfunded, the Plan will not constitute a "retirement compensation arrangement"… .
• No amount will be included in the income of any Executive…solely as a result of the crediting of DSUs to an Executive's Account… .
• Amounts received under the Plan by an Executive who is a resident of Canada at the time of receipt, including any… source deductions, will be included…pursuant to subsection 5(1)… in the year of receipt.
• Amounts received under the Plan, by an Executive who is not a resident of Canada at the time of the receipt, to the extent the amount is attributable to services performed in Canada and, if the Executive was resident in Canada at the time he or she performed the services, outside Canada, including any amounts withheld in respect of taxes and other source deductions, will be included in the income of the Executive pursuant to subsection 5(1) and subparagraph 115(1)(a)(i)… .
• All amounts payable under the Plan to the Beneficiary… will constitute a right or thing… for purposes of subsections 70(2) and 70(3)… .
• …[P]ayments by the Corporation or an Affiliate…will be deductible… for the year in which the payment is made… .

CRA indicated that the full amount received by participants in a deferred share unit (DSU) when they cashed in their units on maturity of the plan would be included in their income from an office or employment under s. 6(1)(a) or (c) or 5(1) irrespective whether the DSUs had appreciated or depreciated from the time of their original crediting to the notional DSU account (based on the bonus amounts the participants deferred divided by the then-current market price of the underlying shares), or from the time that dividend-equivalent units were credited to the account.

Favourable ruling with respect to a deferred share unit plan under which directors can elect to receive all or a portion of their quarterly compensation in the form of deferred units based on the market price for the company's shares but with a provision for the crediting of additional deferred units when dividends were paid on the corresponding shares, and with a further provision that the company may make payment of the deferred units in treasury shares, shares purchased on the market or cash less (in all cases) any applicable withholding taxes.

"Beneficiary" means an individual who, on the date of a Participant's death, is the person who has been designated in accordance with the Plan and the laws applying to the Plan to receive the value of the Deferred Share Units standing to the credit of the Participant on the date of death, or where no such individual has been validly designated by the Participant, or where the individual does not survive the Participant, the Participant's legal representative. … the Company shall make a payment in cash, … to or for the benefit of the Beneficiary of the Participant.

Plan with deferred share units and 3-year bonus deferral restricted share units. "Beneficiary" means any person designated by a Participant by written instrument filed with the Corporation to receive any amount, securities or property payable under the Plan in the event of a Participant's death or, failing any such effective designation, the Participant's estate; … DSU Account shall be redeemed and paid by the Participant's Employer to the Participant or the Participant's Beneficiary, as applicable.

Favourable ruling respecting a deferred unit plan for independent directors of a public company (including non-residents) where they have a choice between being paid deferred units in cash or in shares.